Encana (ECA)

This stock looks OK on first analysis. Not great, but OK. Picked up some shares. If I am betting on natural gas, this is the logical place to be.

The debate here is whether inventories and production will continue to outsupply demand. I think that eventually it has to turnaround. If you are saying that we have a limitless supply of energy so cheap that producers cannot make enough money off of it to justify extracting it from the ground, then it seems like the world energy crisis is solved. Fundamentally I believe natural gas cannot stay at the ridiculously low prices we are seeing now.

What I dont know is how long it will take to start rising. Until then, there is not a whole lot to do but sit and collect the modest 2.5% dividend.

I will try and look into Encana later, but this pick is more about the potential for natural gas than the potential of Encana.

I would appreciate any other picks that might be more promising.

Using share count of 750M, Cash $1.86 per share, Current Assets $5, Debt $10, Current Assets / Current Liabilities $1.68 Book Value of $23 (I would reduce Property by an arbitrary 20% to adjust for difference between cost and actual value. In fact, it is likely worth more than book value in a mature player like Encana, but I will still reduce it for the sake of being conservative. Book value estimate of $18). Current stock price of $28.

Annualized earnings per share of $2.75. With the planned share buyback of 30M shares (admittedly a small portion of the total - approx 5%), all of the above values will improve slightly along with earnings per share, but for the purposes of this analysis, I will ignore the effect of the buyback.

There is likely to be a 20% reduction in revenues during the next year as hedging contracts expire, and the price is reset to the market rate of nearly $4. This could nearly wipe out all earnings for Encana, and has the possibility of leading to a small loss (keep in mind that a share buyback will magnify the loss per share in the same way it magnifies the gain per share). This leaves a 1 year timeline for natural gas prices to begin to recover or Encana will be in rough shape. Given the past history for natural gas prices of continuous decline breaking speculator’s hearts time after time, it is arguably a risky bet.

If we subtract the $18 of book value from the current stock price of $28, we get $10 per share valuation on the earnings potential for Encana. Taking the current earnings of $2.75, that is a little over 3.5 years earnings. After that, any earnings are 100% profit on the share price. This could be calculated as an ongoing rate of return of approx 25% on the investment in excess of the book value (assuming the investment in book value earns 0%). If we combine the two (18/28 x 0% + 10/28 x 25%), we get an expected ROI of approx 9% annually. Not bad, but considering a large expected drop in earnings per share over the next year or so, without rising natural gas prices, the 1-3 year return will be much, much lower.

The lowest I would expect the stock price to possibly go is approx $20-22. The highest it could go depends on the price of natural gas (lets say EPS could double if nat gas gets to $8.00), so this would result in an expected ROI of 18% (18/28 x 0% + 10/28 x 50%) and a stock price of roughly $40. Given the ridiculous oversupply, I don’t know if this will lead to high natural gas prices any time soon. Still from these levels, a relatively small change in the price of natural gas will be a huge % change and can move the stock price quickly.

Keeping in mind that 40% (approx $2.5B) of reported expenses in the current year are non-cash (related to depreciation – cash already paid), so cash flow should significantly exceed earnings, and there is little danger to the finances of Encana.

The implied interest rate on debt is approx 5% (no significant changes in debt balance over the year, so this number should be reliable). This means that the banks have faith in Encana from a risk perspective.

Now, EPS may not impress, but Encana’s cash flow does. They will continue to add more and more cash, and if the stock price for juniors is held down due to natural gas prices, Encana will be free to make a number of bargain acquisitions to increase profits when prices increase in the future. If Encana’s own stock price is held down, they can use the cash to continue to buy back shares as they are doing now. It is a great time for taking a long term view.

Summary: I just don’t know about Encana. It is not a great pick at the moment, since there is nothing in their path but bad news, but it has the potential to be great with a turnaround in natural gas prices. I am buying now, but I am not at all confident that the timing is right, since there may be a chance to buy even cheaper after their hedging contracts expire and profits plummet.

What do you think? Natural gas turnaround within 1-2 years?

OK, thinking about my analysis a little more, I think it may not be the right time for this stock. I sold today at break even. I will definitely be keeping an eye on this one for later. Really just waiting for an overall market correction.

I really, really like the news that Encana is going in on the joint venture for liquefied natural gas out of BC (with Apache and EOG I think). This shows very good long term potential for the price of natural gas to increase as foreign markets can pick up the slack in domestic demand. Downside is that this project will take a while to get going, and we have no idea how competitive it will be in terms of cost. Also, oversupply is not just a domestic problem, I understand the situation exists globally.

Anyway, with price declines, Encana is looking more and more attractive and I am accumulating slowly.

bought some yesterday and today... anybody else? or other buys on this drop of everything

I have been buying up ECA. Definitely started too early, but the valuation right now looks pretty good. Keep in mind that cash flow is very different from earnings in Encana, and even if earnings go negative (which is likely as the hedge book expires), they will be fine.

Natural Gas starting to turn?

Who knows, have been thinking it has bottomed for a long long time now. But seems inevitable that sustained low prices would lead to large infrastructure developments with coal power plan conversion, trucking companies converting to natural gas, etc... Lots of potential to turn the price around, but the risk is that oil company lobbyists campaign for additional taxes on natural gas as currently it is exempt.

I just can't see natural gas prices going negative like some people are forecasting. Really? World energy crisis, peak oil, need for green energy, etc... and there is a huge stockpile of almost free energy that nobody wants? Just doesn't make sense.